In 2012, my cousin Zach, a successful Ohio-based entrepreneur, set out to seek a loan to open his third restaurant. His company, Fusian, was growing and he wanted funding to speed up the process. But in no time, it was hijacked from several banks.
When he told me that, I had this moment of shock. How could such a successful and profitable company not get a loan from a bank? If Zach had a hard time getting a loan for his wonderfully successful business, what small business owner could do it? It turns out that banks have failed to keep up with business owners’ demand for credit. In reality, less than 20% entrepreneurs get the capital they need from banks.
Intrigued, I decided to see what “non-banking” options were available and was quickly overwhelmed. Just Google “small business loans” and you’ll see what I mean. Each lender has the same prop value. But what types of products do they offer? Who offers the best rates? Who will work with my specific company?
Transparency in online lending
In 2014, we launched Fundera to change that. Now business owners can apply to dozens of the best online lenders with just one application. Throughout the process, they work with our team, ensuring they understand which products are best for them based on their financial qualifications and use case. And with a marketplace that caps the industry, business owners can walk away knowing they’ve received the best rate out there.
At Fundera, we prioritize education. Our big picture gives us a unique perspective of the industry, and that view is one we want to share with business owners. We reinforce our commitment to education with this column. I’m going to take all the amazing information we learn from our lenders, business owners, industry leaders, and translate it to help other business owners start their search for financing with purchasing power. You’ll know what’s going on, what to expect, and what to watch out for.
To start, let’s talk about one of the hottest topics in the industry:cash advance loans.
The Dangers of Cash Advance Loans
Cash advances, also known as merchant cash advances, are the product that gave birth to the online lending industry. A solution for business owners who needed cash but were unable to be approved by the bank, MCAs provided business owners with cash, which would be reimbursed (with fees), from a set percentage of their daily credit card sales.
For companies that used to be told “no” when they needed funding, MCAs were revolutionary.
However, it wasn’t long before lenders saw companies’ reluctance to change their payment processors (something many MCA companies need). Not to mention, the direct lure of daily sales was daunting for these hard-working entrepreneurs. They worked for hours to make these sales only to see a significant portion gobbled up every day.
Over time, this led to the development of short term loan product, term loans 3 to 18 months duration, reimbursed daily by ACH Direct Debit from a business bank account. Although it still hits the business owner every business day, not having to switch payment processors and take a percentage of daily sales made the product easier to sell. What we’ve seen unfold as the two products continue to differentiate is that short-term loans have also become cheaper than MCAs.
Together, MCAs and short-term loans make up a good portion, if not the majority, of loans available online. But they can be very dangerous products if not approached wisely and used correctly. Here are 3 things to watch out for when it comes to these short-term loan products:
- Does it fit your business model?
With MCAs, you reimburse a set percentage of your daily sales. So even if you repay more when business is good and less when business is slow, if you don’t receive a ton of daily transactions, it will take you forever to repay the advance. Similarly, with short-term loans, you are debited every working day. If you don’t have money coming into your bank account frequently, it’s possible that these withdrawals will leave your bank account at $0, if not negative.
Cash advances and short-term products tend to work best for businesses that perform day-to-day transactions, such as restaurants or salons. If you only receive a few large payments per month from your clients, you should have a conversation with your accountant, financial advisor, or lender to see if this product will actually work for you. Or better yet, avoid it altogether. I understand sometimes that might be all you’re qualified for, but you don’t want to find yourself paying high overdraft fees on a regular basis and putting your business in a compromising position.
- Is that all you can claim?
Another hurdle that business owners face when seeking financing is with loan brokers. While there are loan brokers out there looking out for the best interests of small businesses, there are too many who are only looking out for themselves. Loan brokers have been known to call business owners daily, telling them they can get them financing, fast! You’re probably ignoring them by now, but what happens when you need quick cash to start a project? It’s far too tempting to say “Let’s go” to the person on the other end of the line.
More often than not, these brokers offer cash advances and short-term products because that’s where the broker makes the most money. But that doesn’t necessarily mean it’s the only product you can claim. I can’t tell you how many times companies have asked us to refinance short-term debt when they could have qualified for a longer-term, less expensive loan. Not taking the time to shop around and see if you have a cheaper option could end up costing you thousands of dollars.
- What do you use the money for?
I’ve said this many times before, but it’s important to stress that cash advance loans are extremely expensive. And while short-term loans can be more affordable, they can also be extremely expensive. This is why you should think twice before incurring this type of debt.
If you’re looking for funding for an income-generating opportunity, that makes a lot more sense, assuming you’ll get more out of the opportunity than the cost of funding. But if you’re looking because you’re short on money, be careful. While that might be all you can claim, do you have a clear plan on how you’re going to pay it back? It might be best to explore other ways to put your business back on better financial footing.
If you’re considering a cash advance option or even a short-term loan, keep these things in mind. Always start your search for financing early, so you don’t fall back on a loan product to save time. Shop around, think carefully about how it will be paid back, and make sure the payment structure is right for your own business model. Your business and bank account will be better off in the end